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If CMC were to borrow floating then they would pay Y + 0.4%
If the counterparty were to borrow fixed then they would pay 3.8%
So in total they would be paying Y + 0.4% + 3.8% = Y + 4.2%A way in which they could both save on the interest is to borrow the ‘opposite’ (i.e. fixed instead of floating and vice versa) and pay each others interest.
If CMC were to borrow fixed then they would pay 2.2%.
If the counterparty were to borrow floating, then they would pay Y + 0.8%.
So in total they would pay 2.2% + Y + 0.8% = Y + 3%So between then they would save 1.2% by doing this. The bank changes 0.2% to each of them for arranging it, but there would still be a net saving by having the swap.
(The answer carries on to show how it would actually work, but that was not necessary in the exam)
Sir i have a question in the solution(SWAP) you have given.
-This part carries 6 marks will the solution is sufficient for 6 marks? If not what additional points are need to explain?
-Please explain what will be the ultimate affect i.e at what rates two parties would be paying interest at the end and how?
-In the BBP kit solution it is given that counter party(bank) will pay 2.4% and CMC receive 2.4%, how is that?I have recorded a full answer to this question which will answer your points.
You can find it linked from the main P4 page ( the link is “P4 Revision and past questions”.
I assume that you have already watched my free lecture on swaps?
And you have watched the lecture working through this question?
If you have then:
a) yes – what I do in the lecture is enough for the 6 marks
b) I explain the ultimate effect in the lecture
c) there is no rule about how the parties settle up (and in fact it is irrelevant for this question because it was not asked for).I have no problem in calculating the benefit which each party will receive, in this question it is 0.4% to each, and question also requires the demonstration.
The problem arise when i calculate the ultimate affect i.e the rate at which each party will end up, this is main issue which I have. I fully understand the 2 example you did in the free lectures, I have solve them myself.What was common in those examples and in this question is that the rate at which two parties can borrow on their own is greater then the other combination of floating and fixed.
Like in this question the combination of fixed and floating if CMC and Counter party borrow own there own is higher than opposite combination of floating and fixed.
What if question states that CMC is interested in fixed and counter party is floating, in this case the total will be equal to Floating+3%,
AND if this is exchange i.e CMC floating and counter party at fixed than total is =Floating +4.2%. According to me this will bring loss.A swap can only make a gain in one direction.
If the question had said that CMC wanted fixed and the counter party wanted floating, then there would certainly be a loss by swapping and so they would not enter into the swap arrangement.
Swaps are not always beneficial 🙂
OH…!
Thanks God.
Finally I get the point, This was actually the point which was disturbing me.
Thank You Very much 🙂 🙂
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